Chris Savage on Two-Tiered Internet

I subscribe to a telecom regulatory list CYBERTELECOM.ORG and there are some lively regulatory discussions that take place on this list around the clock. One of the current hot topics is how the LECs are after content providers to provide payment to be able to have access to quality connections to consumers. After all LECs and cable companies have monopoly positions and can get away with this pretty easily if the government doesn’t intervene. Chris Savage did an amazing job discussing the two-tiered Internet and raises some excellent points. Take a read for yourself. Nice job Chris.

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Hello all,

This morning I saw my old colleague at Verizon, John Thorne, quoted in the paper Washington Post as saying that Google et al. were supposedly getting a "free lunch" on traffic to consumers. Basically in the lines of Whitacre from SBC/AT&T.

On the theory that "everything old is new again," this whole debate strikes me as relating to what used to be called "rate design." The context was an old-style cost-of-service rate case. Once it was determined that the company needed $XX million in total revenue, the question is, what services should have what prices in order to raise that revenue?

So look at Google: they’re paying $8 zillion monthly not just for "cheap servers" (as John Thorne said) but also for upstream bandwidth to the Internet backbone. Maybe someone on-list knows what they buy and from whom, but my expectation is that they are paying boatloads of money for big, fat connectivity to the Internet all over the country (we’ll leave the world out of it for the moment).

Ditto for Amazon, eBay, Yahoo, etc., etc. They are all paying lots of money already for big, fast pipes to "the Internet."

Now look at me. Always a sucker for instant gratification, I just bought Verizon’s FiOS service for my house. 15 megabits/second downstream, 5 up. I’ve had it for a week, and it’s great. Basically all major web location are just **THERE** — essentially no discernable wait. My firm’s web access portal loads slowly, but being on our IT committee I know that’s because (a) it’s running on a relatively old, relatively slow box and (b) it’s sharing relatively constrained outbound connectivity.

But wait… If I’m paying for [x] bit rates upstream and downstream from my little old PC to "the Internet," and Google et al. are paying for [y] bit rates upstream and downstream from their monster servers to "the Internet," where’s the alleged "free lunch"?

Suppose we make the heroic assumption that the commercial entities selling Google connectivity to the Internet are not, out of some deep charitable urge, selling Google that connectivity at below-cost rates. There’s no reason to think that these rates are subsidized in any meaningful way.

Suppose also that we make the assumption that Verizon et al. recognize that they do face retail competition for Internet connectivity, mainly from cable ops but also from some others. So they feel constrained as to how much they can charge me and my fellow consumers, since if we don’t like their price we can go somewhere else.

This implies that Verizon might not actually be making "enough" money on what they charge me for my service. Their stock price has certainly not indicated any sense on the part of the market that they are in great shape. And if we assume that their stock price is being **propped up** by the market (correctly, IMHO) placing a high value on still-burgeoning wireless services, it follows that the market thinks their landline business is not looking so hot. (Per the Wall Street Journal site, in the last year, VZN stock is down about 15%. NASDAQ is up about 7%, S%P 500 is up about 5%, and DJIA is about flat.)

So, this leads to two conclusions, for me:

(1) Verizon is probably fairly heavily subsidizing its end-user prices for Internet access. (Thanks for the free install, including digging up my lawn & nicely fixing it, for the fiber, and CAT-5-ing my house!) While this doubtless hurts their cable rivals, it hurts Verizon, too. And the market knows it.

(2) Verizon doesn’t think it is going to be able to raise its end user rates any time soon. So if it is going to get itself out of the hole it is digging, it will have to find revenue from some other source **FOR THE SAME SERVICE IT IS PROVIDING TODAY.**

Hence the saber-rattling about charging Google et al. The CLEC access charge order from way back (2002?) made clear that even in a competitive retail market, someone selling "terminating" access to existing customers has an effective monopoly on those customers. That’s why the FCC found it necessary to regulate (by capping) CLEC terminating access rates. Here Verizon is looking to initiate what amounts to "terminating access charges" on Google et al. — the only "monopoly" play available where (a) end user Internet access is competitive and (b) Verizon doesn’t control the prices Google et al. pay for their own access to the ‘net.

Comments? Flaws in the picture? Additions/corrections?

Thanks,

Chris S.

  • Jack
    February 7, 2006 at 8:38 pm

    Rich, the flaw in this is that it appears to assume that Verizon has some sort of divine right to offer DSL service to their customers at competitive rates, even when it means they are selling below cost. Another way this practice could be described is “predatory pricing”, since it’s selling at less than cost in an attempt to attract customers away from the competition (which could have the effect of putting said competition in a precarious financial situation).
    Nobody is forcing Verizon (or AT&T, or any other telephone company) to sell DSL, and certainly, no one is forcing them to offer it to customers at a price that does not allow them to recover their costs. The marketplace may force them to do that in order to attract customers, but in a competitive marketplace there are always winners and losers. If a company cannot make a profit selling a product or service in a competitive market, then they should exit the market gracefully (or at the very least, go into a “holding pattern” where they don’t actively try to sell that service for a while, until the market shakes out a bit and prices stabilize).
    One could make the argument (although I wouldn’t) that with basic telephone service, rates had to be kept artificially high in some cases, because there was no real competition and if the local phone company doesn’t provide service, no one else will (of course, that is by design, and I personally don’t give any points to the phone companies for creating a monopoly situation in the first place, then using it for their own benefit). But this is simply not the case with Internet access – in fact, if the biggest companies were to stop offering broadband, I think that in a few years we’d have MORE competition, because smaller ISP’s would not be afraid of jumping in and offering their own broadband services, for fear of being eaten by the 900 lbs. sharks. Look at all the competition we had for Internet access in the heyday of dial-up ISP’s, and then recall that for the most part, the big phone companies didn’t aggressively try to get into that market.
    The one thing that Verizon and SBC and the other telcos should NOT do is assume that because they can’t quite make it in the competitive market, they can use their muscle to change the fundamental nature of that market. All it would take is for Google and Amazon and eBay to simply refuse to pay, and let Verizon and SBC start impeding customers from accessing their sites. How long do you think it would take for customers of those companies to start switching to cable or wireless broadband? Would YOU stay with a broadband service that doesn’t allow you open access to the most popular sites on the Internet if there were ANY other option available? The phone companies are playing a very dangerous game of “chicken” in a situation where they don’t really have the advantage!
    Sometimes I think maybe the telco executives are playing this situation like a game of (a currently popular card game that I cannot use the name of because the comment form rejects it as “questionable content”) – they know they don’t hold good cards and their hand is about to be exposed, but one thing they are great at is bluffing. If Google and the others fall for the bluff, they win. If Google continues to say, “no way”, but does nothing else, then they haven’t lost anything except maybe a little of their pride. But if, as some suspect, Google is quietly setting up its own broadband network, the big phone companies could be the big losers in this high-stakes game.

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